The profit that traders can squeeze out of the merger of Publicis Groupe SA and Omnicom (OMC) Group Inc. may be worth the risk.
The companies agreed in July to a stock swap to form the world’s largest advertising firm, with ownership split down the middle for the two sets of shareholders and the chief executive officers jointly running the combined entity. Last month though, the executives adopted a more negative tone on the prospects of closing the $35 billion merger as a result of difficulties getting tax approvals from European governments. There have also been reports that the companies are at odds over which one is the legal acquirer and who will fill certain senior positions.
With the transaction already taking longer than the companies expected, analysts including Kepler Cheuvreux now estimate a 50 percent chance that it gets done. For investors willing to take that bet, there’s money to be made after the gap between the deal’s value and the shares, or arbitrage spread, widened to about 2 percent yesterday. Elevation LLC sees little downside to that bet because even if the merger collapses, the companies’ stock prices won’t.
“The shares are starting to price in no deal, and the market is saying this is a bit of a 50-50 call at the moment,” Conor O’Shea, a Paris-based analyst at Kepler Cheuvreux, said in a phone interview. Even so, some of the issues “seem to be surmountable. And given all the assets that they’ve sunk into this, you wouldn’t think they’d drop the deal just like that.”
Peggy Nahmany, a spokeswoman for Publicis (PUB), and Joanne Trout, an Omnicom spokeswoman, didn’t respond to requests for comment on the status of the merger.
Under the deal terms, Publicis investors will receive one share of new stock in the combined company plus a 1 euro ($1.39) special dividend for each Publicis share they own, while Omnicom investors will receive 0.813 of a new share plus a $2 special dividend.
Publicis and Omnicom, after each rising more than 10 percent from late July through December on optimism of the merger, have since slipped close to the prices they traded at before the transaction was announced.
“Given the merger’s complexity and open issues, the transaction is moving slower than we originally anticipated,” Omnicom CEO John Wren said on a conference call with analysts April 22. He cited Chinese antitrust clearance and rulings by tax authorities as issues that are still outstanding.
Paris-based Publicis and New York-based Omnicom are trying to establish their tax domicile in the U.K., while the company will be incorporated in the Netherlands. If they are blocked from doing so, “it could affect the likelihood of the satisfaction of the conditions to closing of our deal,” Wren said. If the companies don’t meet the necessary approvals to complete the deal, “there is no plan B,” he said.
The comments on the call provided some of the “clearest indications” to date that the merger is “facing real challenges,” Brian Wieser, an analyst at Pivotal Research Group LLC, wrote last month in a note, in which he also said the deal is still likely to occur. The tax complications seem to be something the companies can negotiate so that they don’t derail the deal, O’Shea of Kepler said.
“But then the question is, do they want to save the deal? Or are they getting cold feet for other reasons?” O’Shea said. Beyond the approval delays, relations between the companies have “severely frayed,” the Wall Street Journal reported last month, citing unnamed people with knowledge of the situation. They also have yet to resolve a dispute over who will be the chief financial officer of the combined entity, Reuters subsequently reported.
From Omnicom’s point of view, the rationale for the deal may be diminishing, according to Ian Whittaker, a London-based analyst for Liberum Capital Ltd. Part of the draw was Publicis’s presence in faster-growing advertising markets, though the more established markets such as the U.K. and U.S. -- where Omnicom generates much of its revenue -- are starting to become the more appealing areas, he said.
“Omnicom might be having second thoughts about the deal,” Whittaker said in a phone interview. “Omnicom may be looking at it now and saying, ‘Well, we agreed to a 50-50 merger when we needed this exposure, but when we look at it now, maybe these markets aren’t as attractive as we thought.’”
Heightened deal risk is reflected in the stock. Omnicom’s shares closed yesterday at $67.68, about 2 percent lower than the current per-share value of the deal, according to data compiled by Bloomberg.
“You’ve got a lot of political, client, as well as tax considerations that they’re trying to marry,” Philip Palazzo, president of Palazzo LLC, a boutique investment bank that advises advertising companies, said in an interview. “There’s just no way this is going to be seamless and it’s going to be one voice.”
Traders can profit from the increased deal risk by betting on that gap disappearing right away with a consummated deal.
There are likely many merger-arbitrage traders betting on the transaction getting done because the deal offers the chance for them to make some profit if it closes, Betty Chan, a senior analyst at Elevation, said in a phone interview. While the shares now trade at a “pretty normal” discount to the merger price -- meaning gains won’t be outsized -- traders at the same time won’t lose much money if the deal breaks, she said.
Timing of completion may hinge on Chinese antitrust approval. The sooner China signs off on the deal, the less time the companies will have to reconsider it and walk away, according to O’Shea of Kepler.
“That Chinese approval I think is needed as quickly as possible to reignite this process and give them the energy to drive the conclusion of this transaction and overcome all the other complexities,” he said. If that happens, this may be seen as just a “fallow period where both sides got to flex their muscles to get what they want.”
Still, analysts don’t see either company’s shares taking a hit if a merger doesn’t happen. They project shares of Publicis and Omnicom will each rise at least 15 percent in the next year as independent businesses, with revenue and profit rising at both companies, according to data compiled by Bloomberg.
“The deal continues to make sense, so I still think it should get done,” Elevation’s Chan said in a phone interview. “There isn’t a lot of downside and you won’t lose a lot of money, or the spread won’t significantly change, if the deal were to unravel for some reason.”
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